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southern

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									                                                                                                                                                                                   Southern Company




Given                                                  1992                  1993                 1994                 1995                   1996                   1997                   1998                   1999                   2000                   2001                   2002                   2003                  2004                  2005                2006
Kilowatt-hours                         21551                  21551                 21551                21551                 21551                  21551                  21551                  21551                  21551                  21551                  21551                  21551                  21551                 21551                 21551          21551
Average Price/kilowatt-hour            0.056                  0.056                 0.056                0.056                 0.056                  0.056                  0.056                  0.056                  0.056                  0.056                  0.056                  0.056                  0.056                 0.056                 0.056          0.056
Price of allowance/ton SO2                                                                                       $              250 $                  275 $                  303 $                  333 $                  366 $                  403 $                  443 $                  487 $                  536 $                 589 $                 648 $           713
Cost of Capital                          10%
Tax Rate                               37.7%
Allowances Available (tons)                                                                                                254,580               254,580                254,580                254,580                254,580                122,198                122,198                122,198                122,198                122,198               122,198         122,198
 Total Revenue                                                                              $   1,206,856,000    $   1,206,856,000     $   1,206,856,000      $   1,206,856,000      $   1,206,856,000      $   1,206,856,000      $   1,206,856,000      $   1,206,856,000      $   1,206,856,000      $   1,206,856,000      $   1,206,856,000     $   1,206,856,000      ##########

Option 1, No Change                                    1992                  1993                 1994                 1995                   1996                   1997                   1998                   1999                   2000                   2001                   2002                   2003                  2004                  2005                2006
Amount of emission                                                                                                            266550                 266550                 266550                 266550                 266550              266550                 266550                 266550                 266550                266550                266550            266550
Tons of permits to buy                                   This solution values the                                             11,970                 11,970                 11,970                 11,970                 11,970             144,352                144,352                144,352                144,352               144,352               144,352           144,352
                                                      alternative by calculating the
Revenues                                            present value of the incremental,                            $              -      $                1     $                2     $                3     $                4     $               5      $               6      $               7      $               8      $               9     $               10    $          11
-Costs                                             after tax cash flows for each of the                          $        2,992,500    $        3,291,750     $        3,620,925     $        3,983,018     $        4,381,319     $      58,120,085      $      63,932,093      $      70,325,303      $      77,357,833      $      85,093,616     $      93,602,978      ##########
-Depn                                                                                                            $              -      $                1     $                2     $                3     $                4     $               5      $               6      $               7      $               8      $               9     $               10    $          11
EBIT                                                                                                             $       (2,992,500)   $       (3,291,750)    $       (3,620,925)    $       (3,983,018)    $       (4,381,319)    $     (58,120,085)     $     (63,932,093)     $     (70,325,303)     $     (77,357,833)     $     (85,093,616)    $     (93,602,978)     ##########
-Tax                                                                                                             $       (1,128,173)   $       (1,240,990)    $       (1,365,089)    $       (1,501,598)    $       (1,651,757)    $     (21,911,272)     $     (24,102,399)     $     (26,512,639)     $     (29,163,903)     $     (32,080,293)    $     (35,288,323)    $(38,817,155)
EBIAT                                                                                                            $       (1,864,328)   $       (2,050,760)    $       (2,255,836)    $       (2,481,420)    $       (2,729,562)    $     (36,208,813)     $     (39,829,694)     $     (43,812,664)     $     (48,193,930)     $     (53,013,323)    $     (58,314,655)    $(64,146,121)
+Depn                                              Cheapest                                                      $              -      $              -       $              -       $              -       $              -       $             -        $             -        $             -        $             -        $             -       $             -       $        -
-CapEx                                             Alternative                                                   $              -      $              -       $              -       $              -       $              -       $             -        $             -        $             -        $             -        $             -       $             -       $        -
-Delta WC                                                                                                        $              -      $              -       $              -       $              -       $              -       $             -        $             -        $             -        $             -        $             -       $             -       $        -
FCF                                                                                                              $       (1,864,328)   $       (2,050,760)    $       (2,255,836)    $       (2,481,420)    $       (2,729,562)    $     (36,208,813)     $     (39,829,694)     $     (43,812,664)     $     (48,193,930)     $     (53,013,323)    $     (58,314,655)    $(64,146,121)
PV                                                                                                               $       (1,400,697)   $       (1,400,697)    $       (1,400,697)    $       (1,400,697)    $       (1,400,697)    $     (16,891,678)     $     (16,891,678)     $     (16,891,678)     $     (16,891,678)     $     (16,891,678)    $     (16,891,678)    $(16,891,678)
NPV                                            $ (266,379,610)

Option 2, Install Scrubbers '95                        1992                  1993                 1994                 1995                   1996                   1997                   1998                   1999                   2000                   2001                   2002                   2003                  2004                  2005                2006
Additional Cost ($.0013/kwhr)                                                                                    $      28,016,300     $       28,016,300     $       28,016,300     $       28,016,300     $       28,016,300     $       28,016,300     $       28,016,300     $       28,016,300     $       28,016,300     $      28,016,300     $      28,016,300     $ 28,016,300
Revenue reduction                                                                                                $      24,137,120     $       24,137,120     $       24,137,120     $       24,137,120     $       24,137,120     $       24,137,120     $       24,137,120     $       24,137,120     $       24,137,120     $      24,137,120     $      24,137,120     $ 24,137,120

Amount of Polution                                                                                                          26,655                26,655                 26,655                 26,655                 26,655                    26,655                 26,655                 26,655                 26,655                26,655                26,655        26,655
                              Interest on Capital Expenditures is capitialize for
Permits AFS                                                                                                                227,925               227,925                227,925                227,925                227,925                    95,543                 95,543                 95,543                 95,543                95,543                95,543        95,543
                              the years leading up to the start of the scrubbers
Revenues                      (Following SFAS 34).                                                                         56981250              62679375             68947312.5            75842043.75            83426248.13            38468239.23            42315063.16            46546569.47            51201226.42           56321349.06           61953483.97      68148832.36
-Costs                           Caclulation for depriciation base:                                              $       52,153,420    $       52,153,420     $       52,153,420     $       52,153,420     $       52,153,420     $       52,153,420     $       52,153,420     $       52,153,420     $       52,153,420     $      52,153,420     $      52,153,420     $ 52,153,420
-Depn                           143*(1.1)^2 + 503*(1.1) + 72 = 800                                               $      111,999,930    $      111,999,930     $      111,999,930     $      111,999,930     $      111,999,930     $       15,999,990     $       15,999,990     $       15,999,990     $       15,999,990     $      15,999,990     $      15,999,990     $ 15,999,990
EBIT                                                                                                             $     (107,172,100)   $     (101,473,975)    $      (95,206,038)    $      (88,311,306)    $      (80,727,102)    $      (29,685,171)    $      (25,838,347)    $      (21,606,841)    $      (16,952,184)    $     (11,832,061)    $      (6,199,926)    $     (4,578)
-Tax                                                                                                                 (40,403,881.70)       (38,255,688.58)        (35,892,676.14)        (33,293,362.46)        (30,434,117.41)        (11,191,309.38)         (9,741,056.76)         (8,145,778.88)         (6,390,973.21)        (4,460,686.97)        (2,337,372.11)       (1,725.77)
EBIAT                                                                                                                (66,768,218.30)       (63,218,286.43)        (59,313,361.36)        (55,017,943.79)        (50,292,984.47)        (18,493,861.39)        (16,097,290.08)        (13,461,061.65)        (10,561,210.37)        (7,371,373.97)        (3,862,553.92)       (2,851.87)
+Depn                                                                                                            $      111,999,930    $      111,999,930     $      111,999,930     $      111,999,930     $      111,999,930     $       15,999,990     $       15,999,990     $       15,999,990     $       15,999,990     $      15,999,990     $      15,999,990     $ 15,999,990
-CapEx                                         $     143,850,000      $      503,610,000    $      71,970,000
-Delta WC
FCF                                            (143,850,000.00)           (503,610,000.00)      (71,970,000.00)      45,231,711.70         48,781,643.58          52,686,568.64          56,981,986.21          61,706,945.53           (2,493,871.39)            (97,300.08)         2,538,928.35           5,438,779.63           8,628,616.03         12,137,436.08      ##########
PV                                             $ (143,850,000) $             (457,827,273) $       (59,479,339) $       33,983,254     $      33,318,519      $      32,714,214      $      32,164,846      $      31,665,420      $       (1,163,409) $             (41,265) $            978,867      $       1,906,259      $       2,749,343     $       3,515,783     $ 4,212,546
NPV                                            $ (435,838,048)

Option 3, Delay Scrubbers                              1992                  1993                 1994                 1995                   1996                   1997                   1998                   1999                   2000                   2001                   2002                   2003                  2004                  2005            2006
Additional Cost ($.0013/kwhr)                                                                                                                                                                                                    $         28,016,300               28016300               28016300               28016300              28016300              28016300     28016300
Revenue reduction                                                0                      0                    0                     0                      0                      0                      0                      0 $         24,137,120     $       24,137,120 $           24,137,120 $           24,137,120 $          24,137,120 $          24,137,120 $ 24,137,120

Amount of Polution                                                                                                           266550                266550                 266550                 266550                 266550                    26655                  26655                  26655                  26655                 26655                 26655         26655
Permits AFS                                                                                                                 (11,970)              (11,970)               (11,970)               (11,970)               (11,970)                  95,543                 95,543                 95,543                 95,543                95,543                95,543        95,543

Revenues                                                                                                         $              -      $              -       $             -        $             -        $             -        $      38,468,239      $      42,315,063      $      46,546,569      $      51,201,226      $      56,321,349     $     61,953,484      $ 68,148,832
-Costs                                                                                                           $        2,992,500    $        3,291,750     $       3,620,925      $       3,983,018      $       4,381,319      $      52,153,420      $      52,153,420      $      52,153,420      $      52,153,420      $      52,153,420     $     52,153,420      $ 52,153,420
-Depn                                                                                                            $              -      $              -       $             -        $             -        $             -        $     111,999,930      $     111,999,930      $     111,999,930      $     111,999,930      $     111,999,930     $     15,999,990      $ 15,999,990
EBIT                                                                                                             $       (2,992,500)   $       (3,291,750)    $      (3,620,925)     $      (3,983,018)     $      (4,381,319)     $    (125,685,111)     $    (121,838,287)     $    (117,606,781)     $    (112,952,124)     $    (107,832,001)    $     (6,199,926)     $     (4,578)
-Tax                                                                                                             $       (1,128,173)   $       (1,240,990)    $      (1,365,089)     $      (1,501,598)     $      (1,651,757)     $     (47,383,287)     $     (45,933,034)     $     (44,337,756)     $     (42,582,951)     $     (40,652,664)    $     (2,337,372)     $     (1,726)
EBIAT                                                                                                            $       (1,864,328)   $       (2,050,760)    $      (2,255,836)     $      (2,481,420)     $      (2,729,562)     $     (78,301,824)     $     (75,905,253)     $     (73,269,024)     $     (70,369,173)     $     (67,179,337)    $     (3,862,554)     $     (2,852)
+Depn                                                                                                            $              -      $              -       $             -        $             -        $             -        $     111,999,930      $     111,999,930      $     111,999,930      $     111,999,930      $     111,999,930     $     15,999,990      $ 15,999,990
-CapEx                                                                                                           $              -      $              -       $     143,850,000      $     503,610,000      $      71,970,000      $             -        $             -        $             -        $             -        $             -       $            -        $        -
-Delta WC                                                                                                        $              -      $              -       $             -        $             -        $             -        $             -        $             -        $             -        $             -        $             -       $            -        $        -
FCF                                                                                                              $       (1,864,328)   $       (2,050,760)    $    (146,105,836)     $    (506,091,420)     $     (74,699,562)     $      33,698,106      $      36,094,677      $      38,730,906      $      41,630,757      $      44,820,593     $     12,137,436      $ 15,997,138
PV                                                                                                               $       (1,400,697)   $       (1,400,697)    $     (90,720,229)     $    (285,675,413)     $     (38,332,687)     $      15,720,415      $      15,307,667      $      14,932,441      $      14,591,326      $      14,281,222     $      3,515,783      $ 4,212,546
NPV                                            $ (282,530,884)




        Non-numerical Factors:
        - Holding allowances many have a high convenience yield, as they could provide insurance against unexpected
        demands for energy.
        - By choosing the option not to install the scrubbers or to delay their installation, the managers retain the strategic
        option to install the scrubbers at a later date. Installation of the scrubbers may become the optimal solution
        depending on the actual market price of the allowances.
        - There may be pressure from state officials and coal miners to choose one decision over the other.



        Why develop a market for pollution allowances?
              The marginal cost of pollution reduction is not the same across all sources. With a market solution such as
        the one described in the case, the market equalizes the marginal compliance cost across all sources. This reduces
        the cost to society of reducing pollutants.
               An implicit assumption is that the marginal benefit of reduction is the same across all sources. This seems
        plausible for SO2, as it has far reaching effects. The location of the pollution source is less relevant than the total
        amount of pollutants released.
                                                                                                                                                                              Southern Company




  2007           2008             2009           2010              2011               2012              2013                  2014                  2015                  2016
    21551          21551             21551         21551                   21551         21551                  21551                 21551                 21551            21551
    0.056           0.056             0.056         0.056                   0.056        0.056                   0.056                 0.056                 0.056            0.056
$    785 $           863 $             949 $       1,044 $                 1,044 $      1,044 $                 1,044 $               1,044 $               1,044 $          1,044


  122,198        122,198          122,198        122,198               122,198        122,198               122,198               122,198               122,198          122,198
#########     ##########     ############     ########## $       1,206,856,000     ########## $       1,206,856,000     $   1,206,856,000     $   1,206,856,000     ############

  2007           2008             2009           2010              2011               2012              2013                  2014                  2015                  2016
   266550         266550            266550        266550               266550           266550              266550                266550                266550              266550
  144,352        144,352           144,352       144,352              144,352         144,352              144,352               144,352               144,352             144,352

$        12   $         13   $           14   $         15   $               16    $         17   $               18    $               19    $               20    $           21
 #########     ##########    $ 137,044,120     ##########    $     150,748,532      ##########    $     150,748,532     $     150,748,532     $     150,748,532     $ 150,748,532
$        12   $         13   $           14   $         15   $               16    $         17   $               18    $               19    $               20    $           21
 #########     ##########    $(137,044,120)    ##########    $    (150,748,532)     ##########    $    (150,748,532)    $    (150,748,532)    $    (150,748,532)    $(150,748,532)
 #########     ##########    $ (51,665,633)    ##########    $     (56,832,197)     ##########    $     (56,832,197)    $     (56,832,197)    $     (56,832,197)    $ (56,832,197)
 #########     ##########    $ (85,378,487)    ##########    $     (93,916,335)     ##########    $     (93,916,335)    $     (93,916,335)    $     (93,916,335)    $ (93,916,335)
$      -      $       -      $         -      $       -      $             -       $       -      $             -       $             -       $             -       $         -
$      -      $       -      $         -      $       -      $             -       $       -      $             -       $             -       $             -       $         -
$      -      $       -      $         -      $       -      $             -       $       -      $             -       $             -       $             -       $         -
 #########     ##########    $ (85,378,487)    ##########    $     (93,916,335)     ##########    $     (93,916,335)    $     (93,916,335)    $     (93,916,335)    $ (93,916,335)
 #########     ##########    $ (16,891,678)    ##########    $     (15,356,071)     ##########    $     (12,690,968)    $     (11,537,244)    $     (10,488,403)    $ (9,534,912)


  2007        2008              2009            2010               2011                2012             2013                  2014                  2015               2016
######### $28,016,300        $ 28,016,300     ########## $          28,016,300     $ 28,016,300   $      28,016,300     $      28,016,300     $      28,016,300     $ 28,016,300
######### $24,137,120        $ 24,137,120     ########## $          24,137,120     $ 24,137,120   $      24,137,120     $      24,137,120     $      24,137,120     $ 24,137,120

   26,655          26,655           26,655        26,655                  26,655        26,655                 26,655                26,655                26,655           26,655
   95,543          95,543           95,543        95,543                  95,543        95,543                 95,543                95,543                95,543           95,543

74963715.6    82460087.16      90706095.88 99776705.46             99776705.46     99776705.46          99776705.46           99776705.46          99776705.46  99776705.46
 #########    $52,153,420    $ 52,153,420   ########## $            52,153,420     $ 52,153,420   $      52,153,420     $      52,153,420 $         52,153,420 $ 52,153,420
 #########    $15,999,990    $ 15,999,990   ########## $            15,999,990     $ 15,999,990   $      15,999,990     $      15,999,990
$6,810,306    $14,306,677    $ 22,552,686   ########## $            31,623,295     $ 31,623,295   $      31,623,295     $      31,623,295 $          47,623,285     $ 47,623,285
 #########     ##########     8,502,362.57  ##########           11,921,982.39      ##########        11,921,982.39         11,921,982.39         17,953,978.62     17,953,978.62
 #########     ##########    14,050,323.30  ##########           19,701,313.07      ##########        19,701,313.07         19,701,313.07         29,669,306.84     29,669,306.84
 #########    $15,999,990    $ 15,999,990   ########## $            15,999,990     $ 15,999,990   $      15,999,990     $      15,999,990


 ######### ########## 30,050,313.30            ##########        35,701,303.07      ##########        35,701,303.07         35,701,303.07         29,669,306.84     29,669,306.84
$4,845,968 $ 5,421,806 $ 5,945,294            $ 6,421,193 $          5,837,448     $ 5,306,771 $          4,824,337     $       4,385,761     $       3,313,414     $ 3,012,194


  2007        2008       2009                    2010              2011            2012                 2013                  2014                  2015           2016
 28016300    28016300     28016300              28016300              28016300     28016300                28016300              28016300              28016300     28016300
######### $24,137,120 $ 24,137,120            ########## $          24,137,120 $ 24,137,120 $            24,137,120 $          24,137,120 $          24,137,120 $ 24,137,120

    26655           26655            26655         26655                   26655         26655                  26655                 26655                 26655            26655
   95,543          95,543           95,543        95,543                  95,543        95,543                 95,543                95,543                95,543           95,543

 #########    $82,460,087    $   90,706,096    ##########    $     99,776,705      $ 99,776,705   $     99,776,705      $     99,776,705      $     99,776,705      $    99,776,705
 #########    $52,153,420    $   52,153,420    ##########    $     52,153,420      $ 52,153,420   $     52,153,420      $     52,153,420      $     52,153,420      $    52,153,420
 #########    $15,999,990    $   15,999,990    ##########    $     15,999,990      $ 15,999,990   $     15,999,990      $     15,999,990      $     15,999,990      $    63,999,960
$6,810,306    $14,306,677    $   22,552,686    ##########    $     31,623,295      $ 31,623,295   $     31,623,295      $     31,623,295      $     31,623,295      $   (16,376,675)
$2,567,485    $ 5,393,617    $    8,502,363    ##########    $     11,921,982      $ 11,921,982   $     11,921,982      $     11,921,982      $     11,921,982      $    (6,174,006)
$4,242,820    $ 8,913,060    $   14,050,323    ##########    $     19,701,313      $ 19,701,313   $     19,701,313      $     19,701,313      $     19,701,313      $   (10,202,668)
 #########    $15,999,990    $   15,999,990    ##########    $     15,999,990      $ 15,999,990   $     15,999,990      $     15,999,990      $     15,999,990      $    63,999,960
$      -      $       -      $          -     $       -      $            -        $        -     $            -        $            -        $            -        $           -
$      -      $       -      $          -     $       -      $            -        $        -     $            -        $            -        $            -        $           -
 #########    $24,913,050    $   30,050,313    ##########    $     35,701,303      $ 35,701,303   $     35,701,303      $     35,701,303      $     35,701,303      $    53,797,292
$4,845,968    $ 5,421,806    $    5,945,294   $ 6,421,193    $      5,837,448      $ 5,306,771    $      4,824,337      $      4,385,761      $      3,987,056      $     5,461,802

								
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